Sunday, October 31, 2010

C+I+G+(X-M) - What Could Be Wrong with That?

Don Boudreaux of Cafe Hayek had this very interesting opinion piece in The Pittsburgh Tribune. In it, he discusses some of the shortcomings of the C+I+G+(X-M) model we teach our students in macro.

I don't think we should abandon the model because it provides some important insights regarding growth. But I agree with Boudreaux that it lacks detail that can lead us to miss important trends or jump to the wrong conclusions.

I'd be interested in your observations on the piece. Is it worthwhile to point out the shortcomings as well as the value of the data to the students?


Goumindong said...

While it is worthwhile to point out the shortcomings of particular models the article in question was rather poor. Not only is the article incorrect in its conclusions, but it is disingenuous.

The author misunderstands the entire purpose of macroeconomics. Which, rather than to explain detailed phenomena, attempts to explain and describe what happens in aggregate.

Or, to put it in language Mr. Boudeaux would understand. Consumers changing from eating chicken to eating beef tells us nothing about whether or not the nation is at the production possibilities frontier, which way that frontier is moving, or anything about aggregate prices.

Despite micro-economics being important, so are the insights that we can gleam from these macro variables and how they interact with each other.

Until reading that article i would have been fairly positive that everyone who has had an introductory macro-economics course would understand why macro level examinations receive their own handling. Now, I am not so sure.

The other option is that the article is simply disingenuous. The author knows what they're doing and are presenting an attack on Keynesianism to people who have no idea what Keynesian means, let alone have the background and faculties to rationally judge an argument that goes to the mathematical/Analytical underpinnings in a complicated field.

Part of this feeling stems from the similarity of the argument to the more rigorous arguments against "representative agents" and how economists often use "representative agents" in order to shore up the assumptions in economic models (and especially in aggregating). After all, if C isn't homogeneous then you can miss changes in C and therefore you can't do economics using mathematical models. They're inherently wrong due to false assumptions.

While I do not believe that that argument holds (strictly because the assumptions make use of representative agents rather than require them, and often do not purport the strength of conclusions that the critique implies) it is at least an honest argument when its made towards professional economists who have the faculties and background to understand the complaints.

But this is not a rigorous argument and it is not directed at professional economists let alone academic economists. The only reason I can see for this would be to engender the public against certain policies or theories which may end up labeled as Keynesian.


This comment ended up too long, a second part follows.

Also note: I am sure I am mischaracterizing the arguments against representative agents and aggregation and the myriad of other complaints against Keynesian based models. Its not intentional.

Goumindong said...

Beyond that, there are much better ways (at least in my opinion) to get students thinking about the constraints of input and output in models (and particularly the constraints of economic theory).

If you wanted to use the Keynesian model you would start with a simple question of what the outputs are in a Keynesian model. The (major)endogenous variables are roughly production, interest rates, and unemployment.

Then you ask a question to the effect of "is maximizing production good?"... "what if all other things are not held constant?"

Or, to say that a model or framework which emphasizes certain aspects of an economy tend to get us to focus on those things, when those things may not be desirable.

"Growth" for instance, if you believe mathematicians (and you should) is a pretty strictly undesirable thing. Any form of constant rate population based or resource consumption based growth will collapse likely with dire consequences for those having to deal with it. Considering that economists typically assume that smoothed lifetime consumption curves generate maximal individual benefit it seems strange that the societal course seems to be on a path of wild variation and shock.

Yet our economic models emphasize growth because they emphasize production as the key variable of interest.

The result ought to be that models can tell us things, but we need to be very careful about how were using them and what we want them to tell us. Similar to the problems involved in developing models and theories after seeing statistical data results there is a problem in determining "the key interesting variables" after you look at how the model is built.

This contains both the lesson that models contain limited information about the world(they only predict what will happen under certain input circumstances, not what we want to happen, or what we can change) while also informing students that there is no "clear objective" in economics, that models(and for that matter, markets) are tools to define paths to a desired result.

vvimmer11 said...

I am taking an economics class in school right now and I see what the author is trying to say about this model being a very bad way to calculate GDP. In class we never put numbers into those equations because of that fact that there are so many variables that go into this. I think of it as a more of a learning tool to understand what goes into GDP (even though it does leave some things out) but do economists really use this to make future predictions? I'm not so sure. For now I think that this model is good to get a picture of how things are progressing but when the author was saying that economists use this to make exact number predictions I'm not quite sure about that. I want to know what he would do to change what’s "wrong" with this equation. He never really told us a solution but just simply complained about it.

Matt Lopez said...

I feel that two main things that are wrong with this equation is the GDP that is derived from this is not fixed to inflation or deflation. And the last is that this equation is usually used as an indicator of increased GDP per capita. But this doesn't measure the standard of living of a person. For example the economy can be gettign better but the certian incomes of living standards of the citizens can be decreasing.

Tim Schilling said...


GDP data is used frequently, I have been reading a number of books on economic development lately. All of them depend on GDP data to one extent or another. The data is often used for trend analysis and can be helpful in that way.

However, I often wonder about the value of the data for forecasting. There's an old economist joke that goes "God invented decimals to show that economists have a sense of humor."

Tim Schilling said...


You are correct that GDP data translated to per capita GDP doesn't go far enough. That's why economists go beyond the "per capita" figure.

Ask your instructor about the Lorenz Curve which can help determine the distribution of income. I think you will find that information helpful.

If you need a quick link to it, try this one:

alexgaston said...

I agree with vvwimmer that this Mr.Boudeaux man seems to simply complain rather than help with a solution. Also, economists know that they can only make assumptions. They do not believe they can predict the future! Of course there are many variables and what not affecting GDP, but for students trying to simply grasp these concepts understanding every element of GDP and the economy is simply too difficult of a task. Also, I think the GDP model can never be exact...but its as exact as it can be, and it is a good foundation for measuring the economy.

Tim Schilling said...


Thanks for your comment. I think Dr. Boudreaux was pointing out two things. The first is explicit. The second is implied.

First: we often expect this statistic to do too much. And if we expect more from it it needs to be improved.

Second: If we want to improve it, it may be up to some of the newer, younger economists to do it. But everyone must remember that statistics can only tell so much. The narrative is also important.